A Cautious Perspective

11/17/2006 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Tech guru Bernie Schaeffer is known for looking at the big picture, building profits by the market’s gyrations. Here, he foresees a departure from more risky investments as investors push a breakout in the S&P 500 Index...

“Last month I recommended that prudent investors maintain an aggressive cash reserve to cushion against adverse movement and buy put and call options to capitalize on a market that may soon be awakening from a multi-year coma. Recently, I further postulated that the breakout would be to the upside, and that it would be led by the blue-chip heavy S&P 500 Index (SPX). The remarkable persistence of the rally since mid-July took out the May highs with authority by early October.

“Also, although the S&P has been chalking up new 52-week highs with regularity, the VIX has been refusing to break down into the single digits. I find this to be a positive omen for the staying power of this rally, as despite all the talk of the "complacency" being reflected in the "low VIX," we are not witnessing any wholesale capitulation by put buyers or heavy activity by put sellers that would produce a serious VIX implosion.

“I believe this rally could carry the S&P to new high ground by year-end, possibly gaining an additional 12% from current levels. But I also disagree with the enthusiastic assessment of the long-suffering blue-chip boosters, who assert that the ‘value’ in this market is finally being discovered and that this could represent the dawn of a new bull market fueled by investors' increasing willingness to assume the risks of owning stocks. In fact, I believe the S&P rally may well be a manifestation of the beginning of the end of investors' all-out embrace of risk in recent years in the form of huge capital flows into precious metals, small caps, emerging markets, junk bonds, etc.–all at the expense of lower-risk vehicles such as the S&P.

“There used to be a widespread belief among market analysts that the blue chips are the only group that remains strong into a final market top, a concept that often has validity. Of course, this principle was inoperative at the most recent major top fueled by the NASDAQ bubble in 2000. And it will be very easy for us to forget amid the celebration that will undoubtedly occur should we actually see an all-time S&P high over the next few months. But my suggestion still stands–maintain an aggressive cash reserve and continue to utilize options, which remain historically very cheap, as a major vehicle for capturing the big moves in the market.”

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